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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 127236  
Subject: Re: 15 fixed vs. 5/1 mortgages Date: 10/17/2001 12:11 AM
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Hi MHF,

Can you explain what these (hard, soft) actually look like? (ie, what language are we trying to avoid having in our mortgage, for what do we specifically ask, in order to avoid having to worry about this, if an agressive debt paydown is planned?

A "HARD" Prepayment Penalty is a clause that triggers a financial penalty if you pay off more than 20% of the principal in any year, FOR ANY REASON (regardless of a sale or refinancing.) Hard prepayment penalties are almost unheard of on conforming, A-paper loans. On "A-Fallout" (not quite A-paper for some reason,) or SubPrime (stinky-poo credit or no savings, or both,) HARD prepayment penalties MIGHT be mandatory in order to be allowed the size of loan you're looking for.

A "SOFT" Prepayment Penalty is a clause that triggers a financial penalty if you pay off more than 20% of the principal in any year, FOR THE PURPOSE OF REFINANCING ONLY! It does NOT apply for payoffs due to a sale. Thus, I explain "Soft Prepay Penalties" as "REFINANCE RESTRICTIONS."

Different lenders have different lengths of time available for Soft Prepay Penalties, and contrary to common intuition, they can often-times be in the borrower's favor to take them!

When you voluntarily take a Soft Prepayment Penalty on your finance you are agreeing you will not refinance for a specified period of time. This guarantees the lender they can count on receiving a minimum number of months of your agreed upon mortgage interest payments. Since they now know what they can count on, they can more aggressively compete (read that as "drop their rates") to get your loan from the competitors. The lenders know that a percentage of borrowers who take the soft prepay penalties will stay beyond the term-limit, and thus provide even better statistical revenues... while the borrower get the better rates.

The only (meaningful) thing SOFT prepay penalties prevent you from doing is refinancing to a lower rate. As many posters on these boards point out, each refinance needs to be considered in terms of some "hurdle" number; an amount of savings that makes it worth your while in a short enough period.

When rates are so low that in order for them to get even lower (so the next theoretical hurdle rate is achievable) that it's is a historically highly improbable event (like now,) then SOFT Prepay Penalties are pretty much a "lower rate gift" to the borrowers that take them

Very sincerely, I am surprised the conforming lenders even currently offer the soft prepays... it gives them back very little benefit to the discount they offer (usually 1/8 to 3/8 better on rates, depending on the loan size.)

The only exception is "No Cost Loans" (Ray's faves.) In these the lender's have really started to align together in that almost none offer enough rebate pricing on anything under $300k to cover all closing costs UNLESS soft prepay rate schedules are used.

The days of the "refi-sliding down the rates free" for the little guy are pretty much hisstory (at least for now... but just like Godzilla and Don King, you never know when they'll show up again!)

Cheers,
Dave Donhoff
Inspirational Beacon Of All Mortgage Goodness (So THERE!)
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